Is Japan still looking up for long-term investors, or have we just seen another false dawn?

After promising investors so much but ultimately delivering so little, Japan has been a long-running saga of disappointments and failed comebacks.

For Japan-believers this time it was meant to be different, but after barn-storming returns last year the Abenomics-led Japanese shares rush has ground to a halt – leading to questions being asked once again about false dawns.

So is the new era for Japan still on track and where are the best funds and trusts to invest? Philip Scott takes a look.

Land of rising shares: Japan investors enjoyed bumper returns last year but since then things have dramatically tailed off. So what next?

False dawns

A recent change at the top in the so-called land of the rising sun, and a stomping performance from its stockmarket in 2013 has investor interest piqued once again.

Over the past twenty years, Japan, which is now the world’s third largest economy after being overtaken by China in 2010, has delivered its fair share of false dawns.

Despite intermittent market rallies and spurts of optimism, it has broadly been an uninspiring period for investors. While the UK’s FTSE 100 index has jumped 313% over the past two decades, Japan’s Nikkei 225 index has plummeted 36%.

The main thorn in the side of the Japan has been a very prolonged and much documented period of deflation, where the costs of goods and services have continued to fall.

Deflation not only increases the real value of debt, it also puts consumers and businesses off spending and investing because they live in the hope prices falling even further, which leads to lower company profits and a rise in unemployment.

A new dawn?

But 2012 ushered in a new era for the Japanese economy, when Shinzo Abe of the LDP party became Prime Minister. His election came on the back of his commitment to reform the economy, ensure long term growth and end deflation via his monetary policy agenda, dubbed ‘Abenomics’.

The Prime Minister’s plans to revive the economy re-ignited a rally in Japanese equities, spurring on a huge turnaround in interest and last year the Nikkei 225 rebounded, cheering investors after it rose by 27%.

This delivered some fantastic returns for investors in Japan funds and investment trusts. Investment Trust Baillie Gifford Japan saw its share price rise 78 per cent, while the Legg Mason Japan Equity fund was up 56 per cent, according to FE Trustnet figures, and Invesco Perpetual’s Japanese Smaller Companies fund was up 55 per cent.

The bumper returns have tailed off dramatically, however. The Japan Equities sector is down 13 per cent since the start of the year, according to FE Trustnet.

Rollercoaster: Baillie Gifford Japan Trust is up substantially since the start of 2013, but the ride has been far from smooth

For Gavin Haynes, managing director at wealth manager Whitechurch Securities the question now is whether this rally can regain momentum and turn into a prolonged bull market?

He says: ‘While previous rallies have been driven by rhetoric and hope of reforms there do appear to be clear fundamental changes in to the economic backdrop, with a significant improvement in economic growth and signs of an end to the deflationary era.’

Two major parts of the Japanese leader’s plans are hitting a 2% inflation target and a weakening of its currency, the yen and in terms of the latter the impact for Japanese exporters should not be under-estimated given the potential earnings that could be made.

Notably since the start of the year the yen is now down by some 17% against sterling.But it has not all been plain sailing. News that Japan’s economy has expanded by just 0.7% in 2013, down from an initial forecast of 1% coupled with the arrival of an increase in consumption tax from 5% to 8%, has spooked investors and the market has dropped.

Long-term issues also remain. For example, Japan’s ageing population is unlikely to welcome a reduction in their spending power as inflation returns, while high levels of government debt and a reliance on importing energy also remain concerns.

However while the market may have paused company earnings have continued to grow and many believe the economy will be resilient to the consumption tax hike.

Wages are starting to grow, albeit by a tiny 0.1 per cent annually in March, there is very high employment and Japanese investors are being encouraged back into their own stock market, with the advent of the new Nisa – the Nippon Individual Savings Account.

News coming out of Japan can often show how things are changing but also quite how far it has to go. For example, in March carmaker Toyota said it would give its Japan-based workers their biggest pay raise in 21 years. That represented about 0.8 per cent of total monthly pay, the first increase in base wages in six years, according to Reuters.

David Coombs, a fund manager at Rathbone has only recently invested in Japan for the first time in a number of years and believes stock valuations in light of the recent weakness now look compelling versus other developed markets.

He says: ‘Economic data, whilst a little more mixed recently, generally points to an upturn in the economy.’

Better corporate profits, proof of inflation being created and continued evidence that consumer confidence is improving could fuel further gains says Adrian Lowcock, senior investment manager at Hargreaves Lansdown.

He adds: ‘Japanese equities are no longer bargain basement and further rises in prices could drive them to fair value but the weaker yen has helped drive earnings growth and this will continue to feed through to the market and should provide some support.’

Where to invest? Top funds and trusts

While the Japanese market may have disappointed over the years, it has proved rich pickings in recent times and some careful stock pickers have been managing to choose wisely, with many achieving good and in some cases spectacular returns.

The £603m JO Hambro Japan fund is fairly concentrated, with just some 60 stocks under its wings. The portfolio, which has investments in household names such as Toshiba, is according to Adrian Lowcock, run by one of the most experienced Japanese equity investors in the business in the form of Scott McGlashan. Over the past five years the fund has notched up a return of 34.74% for its investors, against a Japan peer-group average of 32.36%.

Picked by Gavin Haynes, £315m fund’s manager Chris Taylor, combines a broad economic analysis along with a bottom-up stock-picking approach. Over the past five years, Taylor has delivered a return of 29.9%. Mr Haynes says: ‘The manager is very active and is not afraid to make big judgment calls depending on his views on the Japanese economy, companies and currency and at present the fund is hedged back to sterling, which will be beneficial if the yen continues to weaken.’

Mr Lowcock also tips the £1.2bn GLG Japan CoreAlpha fund, which is up 34% over the past five years. The portfolio focuses on blue-chip business and counts games console giant Nintendo as well as Sony and Mitsubishi among its top investments. Lowcock says the stock selection has been excellent. He adds: ‘The focus on value companies, those which will benefit from a weaker yen has helped drive performance of the fund. Going forward this fund would benefit from further weakness in the yen.’

Sarah Whitley manager of the popular £259m Baillie Gifford Japan Trust, currently on a 2.5% premium, invests across a spectrum of large, medium and smaller companies. Cited by Mr Haynes, he highlights her near three decades of experience in the market. But in just the past five years, the portfolio has amassed a substantial 161% return for its investors. The manager currently favours manufacturing and electrical business which account for more than 30% of the fund and counts the likes of Yaskawa Electric Corp. and play.com owner Rakuten among its top plays.

The £185m Schroder Japan Growth Trust, also recommended by Mr Haynes currently appears attractively valued, given it is up a respectable 75% over the past five years and is trading at a 11% discount. It lists car manufacturer Toyota among its top 10 holdings. He says: ‘The trust’s manager Andrew Rose is very experienced and this is a good choice for investors seeking core Japanese stockmarket exposure.’